CDF: Gradual Depreciation Ahead

We expect that the Congolese franc will remain in a broad, depreciatory trend in both the short and the long term as political strife, negative real interest rates and monetary tightening in developed markets create downside pressure on the currency.

Depreciation will be much more gradual than in 2016 and 2017, however, as robust export growth and a neutral policy stance from the Banque Centrale du Congo (BCC) will prevent a more rapid sell off.

Though we believe that most political risk is already priced in, there is a chance that if the upcoming election period leads to a more substantial collapse of government control and greater violence than we expect, then the unit may face more intense depreciatory pressure.

BMI DRC CURRENCY FORECASTS

f = BMI forecast. Source: Bloomberg, BMI

Spot

2018f

2019f

CDF/USD, ave

1621.00

1686.88

2226.93

CDF/EUR, ave

1898.23

2024.67

2661.18

Central Bank Policy Rate, %

14.00

14.00

14.00

Short-Term (three-to-six months)

In the coming several months we expect that depreciatory pressure will build gradually, leading to a moderate weakening relative to the US dollar. Inflation - though cooling - remains elevated, coming in at 34.1% year-on-year in April, while interest rates are at 14.00% meaning that real rates are negative and will drive depreciation. Meanwhile monetary tightening in developed markets (DMs), particularly in the United States, will continue to put downward pressure on the value of the franc versus the US dollar.

Franc To Stabilise On Stronger Exports

DRC - Exchange Rate USD/CDF

Source: Bloomberg, BMI

Ongoing political crises will likely keep investor sentiment subdued, in addition to new mining code revisions that increase operating costs and building tensions surrounding the delayed presidential elections ( see 'Political Instability To Continue In The Democratic Republic Of The Congo', July 20). We also expect that the internal displacement of at least three million citizens and ongoing outflows of Congolese nationals to neighbouring countries will put pressure on the unit as people seek to exchange francs for the currencies of their host countries. Despite this, we maintain that most of the political headwinds have been priced in already, meaning that further downward pressure on the franc will be limited relative to the degree of depreciation in the last twelve months.

Despite these factors, we anticipate that improving terms of trade will be supportive of the exchange rate in the short term, preventing a faster sell off. Our Commodities team expect that the price of copper - the DRC's main export - will rise by 12.9% in 2018, supporting the value of the franc. Indeed, the unit has been trading in a narrow range between CDF1540.0/USD and CDF1640.0/USD between August 2017 and July 2018, which represents relative stability after the unit lost 76.5% of its value between November 2016 and August 2017.

Long Term (Six-to -24 months)

Over the long term, we expect that depreciatory pressures will remain, as monetary tightening across DMs persists into 2019, leading to ongoing pressure on the Congolese exchange rate. Real GDP growth will therefore accelerate, but be somewhat weaker than average in 2019, as political headwinds continue to weigh on consumption and investment, likely reducing investor appetite and weighing on the exchange rate ( see 'Growth In The DRC To Be Sustained By Mining Sector', July 26). Meanwhile, political risks will remain potent as the country is likely to face the aftershocks from a December 2018 election that will very likely produce a disputed result, prolonging depressed investor sentiment.

Despite these headwinds, we maintain that the franc's depreciation will remain modest and gradual - mainly due to the robust expansion of exports expected in 2018 and 2019 - led by cobalt and copper ( see 'Metals Exports To Sustain Congolese External Account Stability', July 24) - supporting US dollar inflows. Robust export growth will also help international reserves to recover somewhat from its relatively weak position in June 2018, when its level stood at five weeks' worth of import cover. We also anticipate that real rates will improve as inflation subsides and the BCC keeps its policy rate on hold at 14.00%. Finally, in real effective exchange rate (REER) terms, the unit is relatively competitive compared to historic levels, after the dramatic sell-off seen in 2016 and 2017, reducing the scope for further significant sell-offs.

Risk To View

Although we believe that most political risk is already priced in, there are significant downside risks to our outlook if the political situation deteriorates more dramatically than we expect. At present, we anticipate that overall political order in the DRC will remain broadly intact, notwithstanding its many structural weaknesses. We therefore do not see mounting unrest in cities and strengthening insurgencies in some provinces as sufficient to fundamentally change the status quo. However, there is a low probability but high impact risk of a loss of government control over much of the country if the election crisis instigates mass civil unrest or if other countries are drawn into military action in the DRC to deal with unchecked rebel groups. Under such circumstances, the unit could sell off much more rapidly than we currently expect as far more people would then flee the country and investor sentiment and economic growth would weaken considerably.